The Wealth of Nations Summary (8/10)

The Wealth of Nations by Adam Smith was written at a time when Mercantilism was the dominant economic policy. Those who advocate mercantile policies think that for any country, imports are bad while exports are good.

But what Adam Smith argued for, was that the key to growth and prosperity, was not to engage in a zero-sum game of trade wars with other countries, but to expand the size of the economic pie for all. Smith thought that government intervention cannot possibly be more efficient than the “invisible hand.” When markets can operate freely, the gaps in society, in terms of what customers want, will be filled by self-interested individuals, who want to make a profit.

To understand his argument, it is important to appreciate the difficulty of controlling highly complex systems (an economy). When a few individuals in government want to grow the economy, they will look for obvious top-down solutions. One of these solutions is to make sure that exports are greater than imports, to end up with a more favorable balance of trade, and to have more money going into the country than out.

But there are repercussions to this that cannot be foreseen with accuracy, as is the case in complex systems.

The Population is Worse Off

When imports from a neighbouring country are restricted, the local competitors in the home country are better off, since their goods are now relatively cheaper. But, the well-being of the rest of society is not better off. They could have bought the imported product (cheaper) and had more money left over to buy other things, or they could have used the imported product in their own businesses (reducing costs of production).

With free trade, not only are consumers better off, but both countries are given more economic opportunities, since their costs of production are cheaper.

While mercantilist policies work in the short run, they don’t work in the long run. In fact, they end up doing much more harm than good.

Specialization

Smith backs his argument with several reasons. The idea of comparative advantage is a main one. The division of labor has made countries better off. If people within a country all had to produce what they needed, without specialization, it would be a very poor economy. Likewise, if the world refuses to engage in free trade, it is constricting the growth of the global economic pie.

Because of specialization, a worker in an industrial nation is better off than a king in non-industrial nation. Division of labor works because each person creates more output, and crucially, you are not relying on the kind-heartedness of anyone to do their work, but on their self-interest.

Even philosophers, people who do not engage in physical labor, but who observe things from a distance, can only emerge through such division of labor of groups. There are different classes and groups of people who, based on their circumstances, upbringing, and education, specialize in different fields.

There have been nations in the east such as India and China that have built their economies around inland navigation but have not yet profited from trading with other nations. But there are different kinds of trade, and trade with other nations is not the largest contributor to wealth creation. Home trade is the most beneficial to a country’s economy because money and goods can be exchanged more often and can create more wealth than foreign trade (which is still useful when free).

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